The Mitigation Conundrum

The English court has recently clarified the principles of the duty to mitigate loss. The decision in Thai Airways International plc v KI Holdings Co Ltd [2015] EWHC 1250 (Comm) highlights why an innocent party should carefully consider their options when faced with another party’s breach of contract.

What is the duty to mitigate? In fact, it is not a duty at all as it is not enforceable by anyone. Rather, it is a restriction on the damages recoverable for breach of contract, which will be calculated as if the claimant had acted reasonably to minimise his loss. As a result, upon a breach of a contract, the innocent party suffering the breach must take all reasonable steps available to it to reduce or avoid any loss. A failure to do so may reduce the damages the innocent party is entitled to recover.

The facts Thai contracted with Koito, a Japanese manufacturer, for the supply of aircraft seats. In breach of contract, some of the seats were delivered late and others were not delivered at all. Among other consequences of the breach, Thai was prevented from using five new aircraft for around 18 months until replacement seats were obtained. In order to mitigate its losses, Thai ordered new seats from two other suppliers; they cost more than Thai had agreed to pay for the Koito seats, but were lighter. Thai also leased several aircraft for a term of three years to replace those that could not be flown until the replacement seats were delivered and fitted. As it happened, the replacement seats were installed in the new aircraft during the first two years of the leases.

Thai sought to recover all the costs incurred in purchasing the alternative, more expensive, seats and leasing replacement aircraft. Koito argued that even though costs were incurred by Thai as a result of Koito’s breaches of contract, Thai had also derived certain financial benefits from the mitigating actions taken which had to be accounted for when calculating damages. Thus, Koito claimed that Thai had to give credit for:

Any amount by which the profits achieved by Thai from operating the leased aircraft exceeded the estimated profit Thai would have achieved had the contract been performed and its new aircraft had entered service on time.

Any gains from the fuel savings made over the lifetime of the replacement seats due to the fact that they were lighter than the seats Koito contracted to supply.

Thai’s position was that:

If and insofar as it earned any profits by leasing the aircraft (and other mitigating steps) which it would not have earned if it had not been necessary for it to take those steps in response to Koito’s breaches of contract, Thai need not give credit for such ‘betterment’. Any such ‘betterment’ was incidental to Thai’s mitigation and a benefit it had not sought.

It had no choice but to order the more expensive, but lighter, seats, since no other alternative was available in a limited market. In any event, any benefit that might accrue to Thai would do so in the future and could not be accurately assessed.

The judge also had to decide whether it was reasonable for Thai to enter into aircraft leases with a term of three years.

The Court’s decision The judge awarded Thai its reasonable costs of mitigation, but ruled that Thai had to give credit for:

Any profit resulting from the mitigating actions taken which would not otherwise have been earned, even if these were incidental and an unavoidable consequence of mitigation.

Any benefits from the mitigating actions not yet realised, but which were capable of being quantified with sufficient certainty.

However, the judge also held that the burden of proof in establishing any additional profits or benefits accruing to Thai was on Koito. In the event, Koito was only able to prove the fuel saving and even then only in relation to the replacement seats supplied by one of the alternative manufacturers.

As for the lease term, the judge found that when Thai entered into the aircraft leases it could reasonably expect, even on the most pessimistic assumptions, to obtain replacement seats and bring its new aircraft into service within two years of when the leases commenced. It was also found that two years was a reasonable commercial lease term which Thai could have entered into and the choice of a three rather than a two year lease term was driven by other commercial considerations. Accordingly, the judge found that the decision to lease the aircraft for a third year was not a step which was taken, nor which it would have been reasonable for Thai to take in mitigation of loss, and was therefore not attributable to Koito’s breaches of contract.

Comment The case is a useful reminder that a party is expected to act reasonably to mitigate its loss. Businesses are often faced with late or non-delivery of goods or services or other breaches of contract. Where alternative means of mitigating are available to a claimant, it should consider the options carefully. It will have to give credit for any financial benefit received from the mitigating action (if proved by the defendant), even if the benefit is unintended and incidental to the mitigation.

That said, the Court recognises that in such cases the defendant is the wrongdoer and the claimant often placed in a difficult situation. Therefore, the standard of reasonableness imposed on a claimant is not a high one. In particular, case law establishes that in deciding what action to take to mitigate a claimant:

Need not risk its money

Is not required to give up any of its rights

Need not risk damaging its commercial reputation

Is under no duty to embark on difficult litigation against a third party, even if indemnified by the defendant

Further, the claimant’s own resources will be taken into account when deciding what is reasonable. However, a claimant who unreasonably refuses an offer to mitigate made by the party who committed the breach of contract may have their damages reduced accordingly.